Many investors are concerned about the situation with the markets, the economy, and their implications in our daily lives.
In 2020, the federal funds rate was cut drastically to nearly 0.05% in an effort to curb the panic of the COVID-19 pandemic. Fear ran rampant. The reserve ratio for banks was cut, which increased the availability of money in the market, essentially flooding it to incentivize businesses and borrowers to invest and borrow despite uncertain times.
What does this translate to for us today?
Inverse Relationships
One of the very first things to understand about economic policy is that there are several inverse relationships.
The most prominent is the Fed’s dual mandate to engender stable prices and a low rate of unemployment. They do not coexist well. We will touch on this topic again momentarily.
Another significant inverse relationship is the one between rates and prices. When rates fall, prices (of goods, services, homes, cars, etc.) tend to rise. This is due to the opportunity created by “cheap borrowing.”
If rates were 10% yesterday, and you can borrow at 1% today, haven’t you basically made or saved that 9% difference?
The basics of economics is supply and demand. When rates dropped in 2020, demand increased for borrowing in the following months because borrowing was so “cheap.” But as many of us capitalize on these opportunities provided by an interest rate cut, the demand, or the number of borrowers eager to buy, increases and often results in more buyers than actual goods available.
When this phenomenon occurs, prices tend to skyrocket to the price offered by the highest bidder.
That is exactly what has happened with the housing market over the last two years. You’ve probably heard the term “it’s a sellers’ market.” Effectively, because there were so many available buyers, sellers could sell their property to the highest bidder, often bypassing ordinary costs such as inspections because of the pool of overeager buyers.
This occurred with many goods during the pandemic, as you certainly remember with the toilet paper fiasco.
Inflation Vs. Unemployment
One additional inverse relationship that is crucial to discuss is the relationship between inflation and unemployment.
True to the term inverse, when inflation rises, unemployment is low. The federal reserve strives to keep these two numbers within reasonable ranges, but it is often a challenge. In today’s markets, inflation is running high, with the most recent data as of June 2022 pegging inflation at 9.1%, the highest since November 1981.
During this period of high inflation, unemployment numbers were exceedingly low. To correct the inflation problem, the Fed must raise interest rates. As rates rise, businesses will be less keen to “invest” and hire additional workers. In light of these rising interest rates, we have seen many companies resort to laying off people.
As unfortunate as it is, unemployment will continue to rise as inflation falls. The Federal Reserve’s actions lean towards a recession rather than allowing inflation to run adrift. Though painful now, in the long term, it is probably the right choice. Pictured below are unemployment and inflation: see how they are inversely correlated.
Today’s Impact
The impact on the average American has been huge.
Many people have had increased uncertainty with the volatile movements of markets due to the slightest words spoken by the Chair of the Federal Reserve Board, Jerome Powell. The announcement of data indicating the health level of the economy tends to send markets screaming up or down.
With the supply chain disruptions commenced by the pandemic, there are many sectors experiencing shortages and backups for several months. Demand for many goods and services is said to have been “pent-up” during the pandemic and is now being released into the marketplace. The Ukraine/Russia conflict impacts markets today, not to mention the currently evolving China/Taiwan issue, as well as the upcoming elections.
What is one to do?
The Historical Solution
Historically speaking, stocks and real estate tend to weather the storms of uncertain economic times particularly well.
Owning real assets tends to be the way to go. Think about it: if you have all cash, and prices go up, you’ve lost. Your money has decreased. Your purchasing power has lost value. But on the other hand, if you owned some real assets and you held on through the turbulence, their value is likely to rise on a similar plane to prices around you, essentially preserving your purchasing power.
Eventually, as markets correct and inflation declines, the historical normality and our hope for the future is that your real assets should, and hopefully will, continue to appreciate in value.
Many of us tend to run our rails hot during hard economic times, and we forget that the stocks we own are not just certificates, but they are true and real ownership of very tangible and profitable businesses. The odds are in your favor that these great companies will continue to deliver value to customers who need their goods and services despite inflation.
Great examples are sectors such as food, energy, and personal hygiene items like toothpaste. Recession or not, when you bleed, you buy band-aids.
Turn to TrueNorth Wealth During Uncertain Times
Risk tolerance and your unique personal situation are pertinent factors in determining the next steps for you in navigating these economic times.
Whether you’ve already retired or you’re knocking on the doorstep, TrueNorth Wealth is the local wealth management firm on your path to financial prosperity and peace of mind.
Our client experience is calculated to ensure your safe passage through markets and your retirement years. Our team of professionals helps to map out your path through a comprehensive financial plan and ongoing assistance as we implement the plan to help you live the life you’ve dreamed of. Contact a fiduciary in Boise, Idaho, or parts of Utah near you by scheduling a consultation with us!
